Due Diligence In Merger And Acquisition

What is due diligence?

Due diligence in mergers and acquisitions (M&A) is a multidisciplinary verification process aimed at thoroughly examining the legal, tax, financial, and operational situation of a target company before completing a merger or acquisition transaction (M&A).

In international M&A transactions, corporate due diligence plays an even more strategic role, as it involves the regulations of multiple jurisdictions, aspects of private international law, and potential cross-border risks.

What is the scope of M&A due diligence?

Due diligence aims to provide the investor with a clear, complete, and reliable overview of the legal and tax situation of the target company, allowing for an informed assessment of the risks and opportunities associated with the transaction.

Although it is a tool typically used in mergers and acquisitions (M&A), its importance also extends to other contexts, such as private equity investments, public takeover bids, joint ventures, corporate restructuring processes, and international sales and acquisitions.

In the context of M&A transactions, due diligence enables a thorough analysis of the target company, providing a crucial foundation for informed negotiation, both in terms of contractual clauses and pricing.

Moreover, due diligence is essential to accurately determine the value of the target company and to negotiate representations & warranties and indemnities in the Share Purchase Agreement (SPA).

What are the Types of Due Diligence?

In mergers and acquisitions (M&A) transactions, due diligence consists of a thorough analysis of the financial, legal, operational, and commercial situation of the target company, aimed at verifying the accuracy of the valuation, identifying potential risks, and assessing the strategic consistency of the transaction.

The main categories of due diligence include:

• Legal Due Diligence: examines the corporate structure and governance of the target company (bylaws, shareholder agreements, and powers of directors). It also reviews strategic commercial contracts and assesses the existence of ongoing or potential disputes. In international transactions, it is essential to verify any conflicts between national laws and jurisdictional issues.

• Financial, Tax, and Accounting Due Diligence: analyzes the target company's tax and fiscal position, as well as the risk of future tax assessments related to violations of national tax regulations. More generally, it provides a detailed and comprehensive review of the target company's economic and financial situation. This typically includes, without limitation, an examination of the company's filed financial statements and cash flows, economic projections and their underlying assumptions, capital expenditure plans, inventory management, and the company's debt and receivables positions. It also identifies any unrecorded liabilities. Tax due diligence is crucial to avoid future tax liabilities.

• Human Resources (HR) Due Diligence: focuses on reviewing employee contracts, company policies on vacation, sick leave, and other types of absences, and analyzing potential personnel issues such as claims for unfair dismissal, harassment, discrimination, or ongoing disputes with current or former employees. It also assesses the potential financial impact of ongoing labor disputes, arbitration proceedings, or formal complaints, as well as reviewing the overall workforce, including active positions, vacant roles, contracts nearing expiration, and applicable notice periods.

A thorough HR due diligence enables a more accurate estimation of potential liabilities and allows the integration of appropriate contractual safeguards into the acquisition transaction.

How is due diligence carried out?

The M&A due diligence process is structured as follows:

1. Non-Disclosure Agreement (NDA)
2. Access to the data room (virtual or physical) – a digital platform provided by the seller where all relevant documents regarding the target company are collected and shared.
   The data room allows the seller to upload the documents listed in the due diligence checklist, a detailed inventory prepared by the buyer's legal advisors that identifies all the information necessary to reconstruct a complete picture of the target company's legal, financial, and asset situation. Key documents typically include corporate records, financial statements, contracts with clients and suppliers, financial reports, insurance policies, administrative authorizations, registered trademarks, and specific certifications, as well as personnel and tax-related documentation.
3. Document review conducted by lawyers, tax advisors, and financial consultants.
4. Preparation of the due diligence report with risk mapping
   The results of the verification process are compiled in the due diligence report, a written document summarizing the analyses performed on the reviewed documents and presenting the conclusions. This report highlights the identified risk areas, their level of significance, and potential corrective actions or mitigation measures.
5. Support in contractual negotiation

What are the risks of not performing due diligence?

Due diligence is a tool for risk prevention and investment protection.

Without thorough due diligence, the buyer may be exposed to:

• Undisclosed pre-existing debts
• International litigation
• Significant tax penalties due to tax non-compliance by the target company
• Substantial financial losses

Arnone&Sicomo – International Law Firm: How can help you

Arnone&Sicomo is an international law firm, with offices in Rome, Milan, Palermo and Salerno.

Our International Law firm has a comprehensive team of lawyers and tax advisors capable of managing and coordinating the most complex mergers and acquisitions (M&A) transactions in Italy.

Our expertise covers all aspects and types of M&A operations and corporate matters, providing support to foreign investors who seek to protect their investments through thorough and complete legal, tax, and corporate due diligence.

If you are considering an M&A transaction in Italy, rely on us. We put our experience in international corporate law, commercial law, and M&A contracts at your disposal to ensure the success of your transaction.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.